It now looks like the financial
storm that resulted from the meteorological storm in Texas three weeks ago has
turned into an absolutely huge cluster you-know-what. For those of you who aren’t
keeping score at home, here’s my take on the situation. You might want to read
my previous post
on this subject, since I’m building on what I said there.
1.
The bitter cold that
came to Texas over the Valentine’s Day weekend caused a perfect financial storm:
Demand for electric power soared because most people in Texas heat their homes
with electricity, while at the same time supply was severely constrained
because so much generation was put out of service.
2.
Monday, Feb. 15 was
the Day from Hell in which ERCOT, the Texas grid operator, had to order
large-scale outages in order to keep the system from being completely overwhelmed
(which would have resulted in long-term damage to a lot of big generation –
meaning probably many months of outages after that).
3.
At the same time, the
wholesale market price for power jumped from its normal level of around $20 per
megawatt-hour to $1,200 per MWH. That alone was pretty bad. Unless you compare
it to what happened next.
4.
The Texas Public
Utility Commission was meeting at the same time. Being all very knowledgeable about
the basic principles of microeconomics (although not much more than that, it
seems), they concluded that the fact that the market price was “only” $1,200 –
while at the same time a lot of people were sitting in cold homes and couldn’t get
power no matter how much they would have been willing to pay – meant only one
thing: The price was being artificially constrained by the fact that so much
demand was being curtailed (load was being shed, in power industry terms). They
decided the best thing they could do would be to raise the maximum price to
$9,000 (the highest price allowable) – a more than seven-fold increase.
5.
And they were absolutely
right – at least as far as their Microeconomics 101 course went. If not all
demand is being satisfied (i.e. some people can’t buy the commodity at any price),
this normally means that the true market price is higher than the apparent
market price (namely, the $1200 price at the time). The way you clear the
market in such a situation, according to a highly simplified view of
microeconomics, is you allow the price to rise to the level at which quantity
demanded will fall, because people decide they don’t need the commodity badly
enough to pay the higher price. At the same time, quantity supplied will increase,
because suppliers who didn’t think they could make money at the old price
realize that they can at the new price. Quantity supplied will equal quantity
demanded, markets will clear, and we’ll all live happily ever after.
6.
Unfortunately, those
PUC members never took Micro 102. If they’d done that, they might have learned:
a.
When supply is
constrained by non-economic factors (such as the effect of cold weather on
generation facilities which aren’t prepared for it), it doesn’t matter how high
you make the price – you’re not going to get any more supply. That was
certainly the case in Texas on Feb. 15.
b.
The end consumers of electric
power (i.e. Joe and Jane Consumer) would never be willing to pay the $1,000+/day
prices that would have been required to clear the market anyway. My guess is even
at $300/day, most consumers would prefer to endure some cold, rather than start
to cut into their life savings. In other words, the $1200 price was probably
pretty close to the true market price. It was certainly a lot closer than
$9,000 was.
c. More importantly, consumers almost never know the real-time price of the electric power they're using; they learn what it was when they get their monthly bill. So there was no way they could make an informed decision whether or not to turn their thermostats down to freezing (or even below, if that's possible), when it was always possible that the cost of leaving the thermostat where it was would later prove to be negligible.
7.
So the PUC was clearly
wrong in basing their decision to raise the price on the fact that ERCOT had ordered
so much demand to be curtailed. But anyone with half a brain (a commodity
evidently in short supply at that time and place) should have at least realized
that the rationale for that high price would go away once the curtailments
ended. On the 18th (Thursday), ERCOT stopped ordering curtailments (although
because a number of utilities were still struggling to meet demand, there were
still lots of people without power). Yet they didn’t lower the price by a
nickel until Friday, even though the market price returned to normal by
Thursday. To quote a Wall Street Journal article
from March 4, “On Feb. 18 at 5:30 p.m., for instance, the market price of
electricity was $22 per megawatt hour—and the utility commission’s additional
price on top of the real-time market price, as imposed by Ercot, was $8,979 per
hour.”
8.
So the good news is that
by Thursday, ERCOT was no longer imposing a price that was seven times the
market price. The bad news is that they were imposing a price that was 409
times the market price. In other words, they made the PUC’s original
decision much worse than it already was.
9.
Let’s fast forward to
last Thursday morning. The WSJ, in the article I just linked, pointed out that
a market monitor who had been hired by the PUC said that the market price
should have been restored – according to the PUC’s rules - on Thursday, when
ERCOT stopped ordering curtailments. The Financial Times also had a good
article
that touched on other aspects of this story (thanks to my college roommate Dave
Reed for forwarding me that link). That was 33 hours before the market price
was actually restored. They said that the $16 billion surplus in receipts that
was generated (pun intended) during those 33 hours should be returned to the entities
that paid it (and ultimately, hopefully, to the end consumers whose huge bills
funded it).
10.
The tone of both the
WSJ and FT articles was something like “Here’s a sensible proposal that won’t
make everything right, but it will at least help some of the victims of this
mess.” Neither article quoted anybody who didn’t believe that the PUC would
take their advice and order the $16 billion to be refunded.
11.
So I was very
surprised to read in the WSJ on
Saturday morning that, while the PUC (now down to just two members, since
the chairwoman resigned two weeks ago, and deservedly so. The ERCOT CEO was
fired last week, although he’s still on the job for 60 days) hadn’t made a
final decision on this idea, they’re currently very much leaning against it. The
new chairman worded their reasoning very succinctly: “It is impossible to
unscramble this sort of egg”.
12.
And indeed he’s right.
This isn’t a case of having a bunch of suppliers on one side, who are sitting
on this huge hoard of accounts receivable, and a vast, unwashed (since they
haven’t been able to take showers because their pipes broke) mass of consumers
on the other side, who are facing huge bills. Instead, there are all sorts of
nuances to the story. Here are a few:
a.
A lot of power
suppliers are themselves the biggest victims. That’s because they were under
contract to deliver power during the crisis, but since their plants (or wind turbines)
weren’t operational, they had to go to the spot market for their obligations – meaning
they were paying $9,000/MWH for the power they were delivering, vs. earning
maybe $25/MWH in normal times. The big power producer Vistra said they lost
over $1 billion in the crisis. Exelon’s generation arm lost more than $500
million; Exelon then decided to pull out of the Texas market altogether. And
Brazos electric cooperative, the largest cooperative in Texas, declared
bankruptcy two weeks ago, because they had to pay such high prices to deliver
on their obligations to their customers (who are also their members).
b.
Prices in the natural
gas market also spiked by huge amounts during the crisis. As in the power
market itself, this was due both to supply constraints (most gas wellheads were
no better protected against the cold weather than the power plants were. And
because it’s usually not necessary, gas pipeline companies in Texas don’t
normally take all of the moisture out of the gas before putting it in the pipe,
as happens in colder climes. Thus, many of the gas pipelines froze), and to demand
spiking (because the gas generation plants that were still working were
demanding as much gas as possible, as their owners tried to make all the hay
they could while the sun shone). But this meant that a gas plant owner who was
being paid an astronomical price for the power they were producing was also
paying an astronomical price for the gas they used to produce that power. So if
just the power price was rolled back but not the gas price, they would be in a
deep financial hole.
c.
Large purchasers of
power (manufacturing plants, utilities that don’t generate the power they
distribute, municipal utilities that don’t generate much if any power
themselves, etc) will often (or even usually) hedge their purchases on the futures
market – meaning they essentially buy the power they will need in advance at an
agreed price (and it’s certain that the futures price, since it was probably
set months ago, was much closer to $20/MWH than $9,000). So the big bills those
purchasers received a couple weeks ago would be paid by the speculators on the
other side of the contract; those purchasers just had to pay the much lower cost
of the contract.[i]
d.
On the other hand, the
speculators would have lost a ton of money. Normally, they would just blame
themselves for the losses, since obviously when you play that game you have to
be prepared to lose as well as win. However, if some of the charges get
reversed as suggested, it’s just about certain that the speculators are going
to want some of that for themselves. And it’s likely that the power futures exchanges
(the largest of which by far is the Intercontinental Exchange in
Chicago) have rules allowing those funds to be recouped from the buyers of the
contracts.
e.
But the problem is
that the large purchasers who bought futures contracts wouldn’t receive any
funds if ERCOT ordered the power producers to cancel their big bills to consumers;
they just wouldn’t have to pay more than the price of the futures contracts
they bought. Yet now they would be hit with an order from the futures exchange
to reimburse the speculators. They might in turn go to the power producers for
reimbursement, but the producers will likely argue that, since they’ve been
ordered to return whatever payments they received at the high rate, they
certainly shouldn’t be ordered to reimburse their customers for the fact that
they hedged their purchases.
f.
In other words, it’s
likely the large purchasers will be caught in a really tough legal fight with
the futures exchanges, of which the outcome will be far from certain.
And that last statement pretty
well sums up the electric power forecast for Texas in the coming years: Massive
lawsuits and political fights. Ultimately, I’m guessing there will be some sort
of huge settlement that won’t make anybody whole, but will put most of the cost
on – you guessed it – Texas citizens, in the form of higher taxes and high
power bills. I certainly hope they’ll decide that changes need to be made to
keep this from happening again.
One other thing: You may have
noticed the title of this post refers to $29 billion, but the amount that is
being talked about for a refund is $16 billion. The market monitor decided that
the original PUC decision to raise the maximum rate to $9,000/MWH was made
according to the PUC’s rules, and continued to be so until Thursday, when the
fact that ERCOT ended demand curtailments meant the price should have reverted
to the market price of about $22/MWH (Note: The fact that the PUC had to pay
somebody to point this out to them is incredible in itself). The $16
billion is just the extra cost for 33 hours from Thursday into Friday.
But as I hope I’ve shown, if the
PUC had just applied some common sense on Monday the 15th, they
would have realized there was no case for trying to make the rate go higher
than the market rate, which at $1,200 was certainly high enough to induce
whatever remaining supply might have been sitting on the sidelines. I read somewhere
that, over the entire Monday-Friday period, the difference between the
actual price ($9,000) and the market price led to $29 billion in unnecessary charges
(i.e. if the PUC had just left the actual price at the market price, power
purchasers would have saved $29 billion compared to the bills they actually
received).
Given the recklessness and
incompetence that the PUC exhibited in boosting the price far higher than what
the market said it should be on Monday, and the terminal cluelessness exhibited
by ERCOT in keeping the actual price at that level through Friday (remember,
the $9,000 was the maximum allowed. The PUC didn’t order ERCOT to set the price
at that level. I doubt they had that power, anyway), I think the entire $29
billion should be reversed. Of course, that makes a huge legal mess even worse.
But expecting some power buyers to simply eat the $13 billion unjustified extra
cost for Monday-Thursday isn’t exactly a solution, either. Get everything on
the table and treat everyone equally poorly. And remember the people who got
you into this mess the next time you go to the polls.
Any opinions expressed in this blog post are strictly mine and are not necessarily shared by any of the clients of Tom Alrich LLC. If you would like to comment on what you have read here, I would love to hear from you. Please email me at tom@tomalrich.com.
[i]
This assumes the purchasers were 100% hedged, meaning they’d bought futures
contracts covering their entire needs. Since that’s not the usual practice
(after all, there’s certainly a cost associated with buying futures contracts),
these purchasers almost certainly faced large power tabs for the week of Feb.
14; but those were much lower than they would have been if they hadn’t hedged
at all.
an excellent dissection of the issues and their downstream effects. A lot of news orgs are seeing/covering parts of the puzzle but don't understand the intersections and why this is a bigger hairball than it seems.
ReplyDeleteThis comment has been removed by the author.
ReplyDeleteKevin Perry pointed out to me that end consumers of power would have had no way of knowing what the price was when it was spiking so high. So there's simply no way that any price, no matter how high, would have immediately reduced demand. Just shows what happens when people are stuck in an ideological rut and won't consider stuff like...you know, facts.
ReplyDelete